Is Commodity a Dirty Word?

I hear it all the time. Automotive manufacturing companies, and especially tier one suppliers, don’t want to be considered just manufacturing companies, they want to be “technology companies.” They often believe, or want to believe, that they are cutting edge technology powerhouses representing the vanguard of the industry. They tell Wall Street this, and they try to convince their own employees of it. People desperately do not want to hear or realize that their product has become a commodity. I understand – once you have realized that everything that you have put your blood, sweat, and tears (and a sizable investment) into is now simply “common,” – does not sound like a place one wants to be.

People want themselves, and more to the point, their companies and products, to be special and unique. We are always talking about differentiators. The reason? “Commodity” is a dirty word.

What is a Commodity?

Let’s start with a definition. Commodity, according to Wikipedia, lines up like this: “In economics, a commodity is an economic good that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them.”

“Full or substantial fungibility.” That is precisely why automotive manufacturing companies do not want their products to become a commodity. Can you imagine if your product has become fully commoditized, with “full fungibility” of instances of your product versus your competitors? What if you have already?

I’ve worked in the automotive industry for years, and there are indeed few products that aren’t largely commoditized – almost every supplied part that you see on a vehicle or under the hood is commoditized by the OEMs. There is great talk of innovation and partnering with suppliers, and there are some great technology tie ups out there, no doubt. But when it comes down to it, if you are a Tier One supplier, you are selling a product that is largely commoditized.

Seats, axles, engine parts, batteries, tires, screens, mirrors, door panels, cockpits, seat belts, air bags – just about everything is treated as a commodity. The OEMs like it this way, because it is easier to negotiate on something that is treated in this manner, rather than be forced into recognizing that everything is a carefully engineered product that requires unique commercials and treatment. 

The Commoditization Cycle

According to an excerpt from an article in The Economic Times, “‘Everything commoditises over time,’ says Steve Heyer, the former CEO of Starwood Hotels & Resorts Worldwide and former COO of Coca-Cola. And he’s right. The edges and points of difference get worn off by competition. The facets of diamonds are worn away and you are left with a piece of glass. It is easy to imitate and hard to innovate.”

In the automotive industry, it is even harder to avoid commoditization. Suppliers often are not able to even put their brand information on their product in any recognizable fashion if it is original to an OEM vehicle. Maybe for the occasional battery or a sound system, where the OEM might detect that this could enhance the value of the vehicle by saying they have a certain brand of sound system, then they will allow it.

But do you know who made your seat belts? Do you know who made your seats? Do you know who produced the steering column or the carpets on the floor? Who made that beautiful dashboard or your glove box? Do you know who made the windshield or the headlights?

And the OEMs now understand so much about the cost models of their suppliers – they know the cost of the raw materials, labor, engineering, tools, presses, logistics – so much to the point that for most tier one suppliers, more than half of their direct material spend is actually directed by the OEMs. That means the OEM tells the supplier who they will buy their raw material or component from, and what the price will be. Sometimes they do a cost plus or something for handling the part, but this doesn’t usually recompense the Tier One fully for all of the things that go into the engineering and logistics of handling that part and introducing it into their production process. And in many instances, the OEM simply buys a raw material on their own at massive scale – like steel or resin – and then they farm these commodities out to the supply base as they need them.

Think about it, what does an OEM really want out of their supply base?

• Easy to do business with 
• Best commercials, ideally generated by best internal cost structure, not just weak salespeople 
• Best quality 
• Fungibility of process and approach – same here as there, same for this as for that 
• Meet launch timing! 

 In essence, the Tier Ones are sometimes simply arms-length divisions of the OEMs, but with the OEMs being able to abdicate themselves of a good portion of risk. I understand why the OEMs do it – because often they are selling cars at breakeven or at a loss, so they can’t afford any extravagances in their supply base.

Let’s add some more difficulty – the Tier Ones often have massive manufacturing footprints that they want to keep at near capacity. The OEMs know this, so they will often shop their next programs to different suppliers, looking for the weakness of a company that is willing to do a loss lead to keep its footprint filled. Then they pounce. And then when a new piece of business is available, they do it again, looking for the weakness. And then the Tier Ones ponder on and on, squeezing out low single digit profits, and always at the mercy of the next disruption. If you sat down with the CFOs of many tier one automotive suppliers in the right moment, they would share with you that many of their programs are breakeven or at a small loss, and that they ride the backs of a few gravy trains to drive the business.

Another excerpt from the article in The Economic Times reads, “Timescales are shrinking and the commoditization clock is ticking. Commoditization occurs when you have to constantly improve quality or other product benefits while decreasing prices to keep up with competitors. It also occurs if you have to lower your quality or other product benefits to keep pace with falling prices. The problem is exacerbated when you are caught between rising input costs (such as energy, metals and raw materials) and a loss of pricing power for your products.”

Commoditization is a Dirty Word.

So what happens as this commoditization cycle continues to spin? These suppliers blunder on for a few years with nearly imperceptible margins, they form joint ventures, they trade divisions with other suppliers, some disappear altogether, they go through blind task cost cutting exercises because those don’t require creativity, and sometimes private equity firms will come swooping in, cut some fat (and usually some bone), and then sell the company in a few years unless they hold them a bit too long. And then they are stuck with an albatross on their books.

And on and on.

Can Companies Change their Ways?

What if these companies could right the ship? What if these companies could start to change themselves internally to enhance their capability and their resistance to commoditization? Better yet, what if these automotive companies actually embraced and even sought the commoditization of their products?

Let’s go back to the definition of commodity. The “full or substantial fungibility…” Full, or substantial fungibility. Let’s dig into that. If I sell a product, and another company sells a very similar product, to the point of, then the product has been commoditized. Well, if I have achieved a similar product with an outside company, I should be able to have internally commoditized products as well, correct? Maybe not full, but certainly I could have substantial fungibility within my internal catalogue of products.

This is why most Automotive Tier Ones are a 50 cent cab ride from the brink of collapse. Ok, a 2 dollar Uber ride. They actually do not have hardly any internal commoditization. I see it time and again – the outward products, after all is said and done, are positioned by the OEMs as commodities that simply can be compared from one Tier One to the other. People will drone on and on about innovation, but in the end, in most of the cases, it is the best cost (usually lowest cost) that wins the day. The Tier Ones have very similar capabilities, and can end up with very similar end products and quality.

However, internally, the way the individual Tier One will handle and manufacture these similar products, is often far different even from other similar products in their catalogue. The only “uniqueness” was how that individual part at that time by that plant was compared to how other parts were made at the same Tier One – and that is a killer for a manufacturer that is trying to build high volumes of the same part at a profit.

Let me explain by asking some questions first.

For a Tier One supplier making a specific type of component in different locations, I would want to know the following:

• Is the labor trained similarly in similar functions?
• Are the processes used to create the parts the same?
• Are the machines used to create similar parts the same?
• Is there a clear set of best practices that are updated and shared and drilled into the engineering and manufacturing organizations?
• Do plants share and comply with those best practices?
• Do your teams set up manufacturing lines the same way across the globe? Do they have a template for each type of labor environment, whether inexpensive labor or higher labor cost?
• If I were to look at all of an organization’s plants, how many different ERPs am I going to find?
• How many different MES systems are there?
• How many different sequencers are there?
• How many different PLM systems are there, and are BOMs handled differently throughout the network?

So with all of these differences, you are telling me that you can even try to make a high volume, commodity part at an advanced cost position – when you do things a little bit differently every time?

If I have different systems, there are different processes. That means that every time there is a different process, there is different training, different tasks to be performed, and a rise in inefficiency. And in a manufacturing environment, it gets even worse.

Here’s the dirty little secret. In automotive, nearly every plant has budget that they can free up to go purchase some type of IT solution, or machine, or device, or sensors, or whatever in the idea that it will improve their efficiency, quality, etc. And they are all buying things. They typically don’t talk to the other plants that make the same things – they don’t want their individual effort “slowed down” because they have to partner with someone else, and they don’t want to have to give away decision making power to anyone, and they definitely don’t want corporate to catch wind of it, because that couldn’t possibly be helpful. Right?

So, even if plant A makes the same widgets as plant B, there is often a huge difference in plant set up, systems, training, machines, and continuous improvement initiatives. This harms the potential big ticket actions – like M&A integration, enterprise improvement, or larger scale IoT or Industry 4.0 initiatives, because, if you don’t coordinate and valuate an initiative and every plant does what they want, then if something does come down the pipe at the enterprise level, everyone screams that there is no funding because it truly has been dithered away.

And I have seen moves in automotive away from a center-led organization to a more decentralized approach, and these companies are often forfeiting basic principles of economy of scale, and building far more fragmented processes with little chance for fungibility, because they never truly learned how to govern from the center – they already allowed, fomented, and presided over a fragmented environment, so the inefficient and ineffective leadership structure was blamed on centrality, and not placed at the feet of a lack of true leadership where it belonged. It’s funny because I’ve talked to a company that is famous for decentralization in automotive, yet they have realized that they have no scale on a lot of low hanging fruit – and changes are a’ coming.

Anyway, if a plant does initiate on a true process improvement, then other plants can’t adopt it, because they have not adopted a true avenue to share best practices, there is no governance installed in the organization to determine what is valuable, and they have already consumed their budgets on their own “chocolate milk in the drinking fountain” sorts of initiatives. Some plants are great, and they should.

Preparing for the Disruption Associated with Commoditization

To prepare for the disruption that is coming and is now here, these massive, global, tier one automotive companies need to change their minds about the internal commoditization of their products.

• Advanced manufacturing engineering organizations need to truly be empowered to hone best practices, and then create manufacturing lines and processes in similar ways throughout their footprints.
• Products of the same type need to be developed in the same way, in the same type of design environments and systems.
  
• Companies must understand plant “slush funds” and establish clear rules and methods for governance on continuous improvement projects – don’t look at what is in their budget, look at what they have spent over the past 5 years. Plants are clever in freeing up money to do the things they want.
• Product Lifecycle information should be in the same system on the same set of processes for similar products.
• ERP systems should be aggressively converged, pushed to the cloud, and a single set of best practices should be maintained. The difficulty and expense of procuring servers, building data centers, and staffing IT organizations with people who do not align with the core competency of a company, should cause any CFO or CIO to shudder. Those days are done.

These approaches will allow companies to quickly share best practices, employ them, and fund them. I was recently talking with a manufacturing leader at a multibillion dollar tier one. He was telling me about an initiative that would link their ERP to another toolset and allow them to measure one of their KPIs at an enterprise level in a more effective and accurate way than they ever could before. And the key reason they are able to do this is that they have converged to single processes and systems in the targeted area, and they have achieved that full or substantial fungibility in the process and tools across a major swath of their business. It’s a commodity approach. Companies need to scan their organizations deeply, and look for and engineer these opportunities for fungibility. Then they will realize that Commodity is no longer a dirty word.